FOMC Decision Preview: Fed’s Surprises Still Probable

In order to stop the tightening cycle, the Fed is predicted to raise rates by 25 basis points. In an unexpected decision, the Reserve Bank of Australia unexpectedly increased the cash rate. Tepid data raises the possibility of a recession as the US dollar enters the event in a weak mood.
On Tuesday, the Federal Open Market Committee (FOMC) will begin its discussion of monetary policy, and on Wednesday, it will make its decision. The Fed signaled that it would raise interest rates for a third time in a row by 25 basis points (bps), but also suggested that it might thereafter take a break. The Fed has concluded that the cost of fighting inflation is not worth the danger of an economic downturn after more than a year of abrasive monetary tightening.

End of the tightening cycle?

A banking crisis that appeared in the middle of March hastened the conclusion of the cycle of interest rate increases. Credit conditions for businesses have become much more difficult as a result of US central bank policy, as well as that of its major international counterparts. For more than a year, businesses have had to contend with higher borrowing costs, as well as rising prices and a still-tight labour market.

There are many signs that a recession is about to hit the United States, including an inverted yield curve, weak manufacturing production that is extending over time, and low consumer confidence. How difficult the landing might be will partly depend on how the Fed operates moving forward.

It’s important to keep in mind that the Fed is also striving to reduce a record balance sheet by allowing assets to roll off, including up to $17.5 billion in ageing agency mortgage-backed securities and $60 billion in maturing US Treasury securities per month.

Surprises are still possible

Jerome Powell, the chairman of the Fed, will probably leave the door open to other possibilities. Since the rate of inflation decline has been slower than expected, Powell and company may decide to condition further tightening on information. But you should exercise caution. Between the March meeting and this one, another American bank failed, and the Fed was forced to acknowledge the fact that the problem is far from over.

The probability of a rate increase of 25 basis points is above 85%, thus the US dollar won’t be significantly affected because it has already been factored in. If the central bank makes a different decision, chaos might spread throughout the FX board. Even thinking about it might seem absurd, yet the Reserve Bank of Australia (RBA) shocked the financial markets on Tuesday by raising interest rates by 50 basis points. Australian central bank demonstrated to market participants that all options are on the table during central bank meetings, despite the fact that Australian and American conditions are significantly different.

Regardless, with the anticipated hike, attention will turn to Chairman Powell’s remarks on the direction of monetary policy and how concerned policymakers are with the current financial situation. It will be very challenging to calm the markets, but Powell is the man who can.

Future prospects for the US dollar

The tone of the American currency is weak going into the event. The US Dollar Index (DXY) reached a high of 103.25 on Tuesday, its highest level since mid-April, but it has since given up its gains due to a deteriorating market climate and is now struggling to hold onto 102.00. The DXY is trading just slightly above a multi-month low of 100.80 set in February, according to technical readings on the daily chart, and is in a negative trend.

However, the Dollar Index DXY is retreating abruptly after failing to overcome a bearish 200 Simple Moving Average (SMA). While turning lower, technical indicators have remained positive and in line with the prevailing trend. Finally, on the way to the weekly high at 103.25, the previously indicated 200 SMA serves as resistance at about 102.20.

The likelihood of a DXY bearish breakout towards 101.00 increases with Fed dovishness, whilst a spike towards the recent high on a hawkish posture falls short of signaling a change in the prevailing downward trend.